Knorr-Bremse AG

and welcome to the Knorr Bremse AG Q2 2022 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Andreas Spitzauer, Head of Investor Relations. Please go ahead.

Thank you, Elaine. Good afternoon as well as good morning, ladies and gentlemen. My name is Andreas Spitzauer, Head of Investor Relations of Knorr Bremse AG. I want to welcome you to Knorr-Bremse's conference call for the second quarter 2022 results. Today, Frank Weber, our CFO, will present the results of Knorr-Bremse, followed by a Q&A session, which will be joined by Dr. Jürgen Wilder, head of RVS as well. The conference call will be recorded and is available on our homepage, www.knorr-bremse.com, in the Investor Relations section. Here you can find today's presentation and later a transcript of the call. It is now my pleasure to hand over to Frank. Please go ahead.

Thank you, Andreas, and a warm welcome, everybody, to our conference call. We appreciate your joining us today. I will start with the last quarter and the outlook for 2022. Afterwards, Jürgen Wilder and myself look forward to your questions. Bernd Spieth, head of CVS, was unfortunately unavailable to attend today as he has important meetings with our customers. I do hope that you understand that. Let's kick it off on chart two with our main messages for today. First, despite many market challenges and macroeconomic headwinds, market demand in both rail and truck continues to be strong in almost all important markets. In China, the markets are much more cautious. Second, we are well on track with our clear action plan to fight increased input costs in both divisions. Third, We are well on track as we have the necessary strength to face all global economic uncertainties, which will not disappear in the near future. But we are prepared and well underway. Our key points in that regard are we drive 37% of our revenues out of aftermarket business. We have a rock-solid balance sheet with very low debt. We are the market leader in rail and truck. Our customers need solid and reliable partners like RVS and CVS that can sustain a crisis like the one we are in. Fourth, we have done two very attractive deals in digitalization well in line with our promise digital business M&A strategy and we walk the talk. Fifth, we had to revise the financial year guidance recently but are well on track to fulfill these targets. On chart three, I would like to share our market view with you. Let me start with the rail market. We see that the underlying demand in both OE and aftermarket business continues to be high, visible in a continuously very good order intake. We do not have any indication that it should significantly decline in the near future. Nevertheless, again, let me point out that the rail is a lumpy business, which does not always go well with quarterly reporting. We have now seen three great quarters in a row, but there might also be weaker quarters coming up in the future. Nevertheless, our good OE trend is long-term intact. Europe remains the strongest market for RBS, but also North America continues to be a solid contributor. The consequences of the Russian invasion in the Ukraine are significant and we expect very little turnover in this country in the future that is not affected by the sanctions. The Chinese market has been characterized by strong weakness over the past quarters with low rail car investments and economic pressures through their zero COVID policy. We now do not expect a significant recovery in half year two either. Overall, we are confident that we will see a subsequent improvement in the global rail industry in half year two, also benefiting from increasing ridership levels. In the course of the year, we expect demand to remain healthy, which should also be reflected in a book-to-bill ratio above one. However, supply chains have also tightened in the rail industry since last year, and inflation is also clearly noticeable. The truck market also experienced ongoing solid demand. Truck production rates in Q2 in Europe and North America developed positively year over year with a positive outlook throughout 2022, only limited by managed order books of our customers. China remains on a very weak level as expected. Supply chain situation and input cost increases are still the key concerns in the truck industry. In the coming quarters, we expect that global supply chain remains challenging, but we see some signs of slight improvements. In regards to pricing discussions with our customers, we are well on track to compensate higher input costs. In the second half of the year, we will be able to book the first results here. High usage rates of old trucks currently drive the aftermarket business, which continues to develop very positively. All in all, the global environment is tough, but the underlying demand is robust too. Let's move to details of the second quarter on chart four. Knorr Bremse generated stable revenues of around 1.7 billion euros and an operating EBIT margin of 10.5%, which was impacted by both divisions. DVS posted revenues of 914 million euros at 8.1 operating margin and RVS 823 million euros in revenues, resulting in an operating EBIT margin of 14.3%. FX effects supported the development on revenues and EBIT, but did not impact the EBIT margin significantly. Free cash flow in quarter two was already significantly better than quarter one, but still slightly negative with 35 million euros. Order intake of 1.9 billion euros increased solidly versus prior year. Please note that the order book also benefited from an upwards adjustment of 375 million euros, which does not affect the order intake. Specific existing orders like prototypes and FX effects, et cetera, are now included in the order book as well. Let's move to chart five. As anticipated, CapEx in quarter two with 77 million euros slightly increased year over year and quarter over quarter, still fully in line with our targets. Larger investments on the rail side were made for footprint expansion in India and capacity increase of brake pads. CVS invested among other areas in supplier tooling in Europe and APAC, as well as in general capacity increases in the regions outside Europe. Networking capital, just as in quarter one, is accepted on higher levels as current uncertain times require higher safety stock and higher flexibility to mitigate disruptions in the supply chains best possible. We have set up a clear action plan, especially for the second half of the year, which will lead to a reduction of the networking capital. Consequently, and also additionally affected by a lower EBIT contribution, ROSI amounted to 16.4%. Let's have a look on the divisional performance in quarter two, starting with RVS on chart six. Order intake of RVS was again remarkably high after two strong quarters, quarter 421 and quarter 122. It increased by more than 40% to 1.05 billion euros. The order book also increased by more than 35% year over year to 4.8 billion euros. The book-to-bill ratio in quarter two was accordingly strong with 1.27. Let's move to page seven. Revenues amounted to 823 million euros, a slight decrease by 3% year over year, but an improvement as anticipated versus quarter one by around 50 million euros. RVS recorded declining sales in the OE business, primarily driven by the APEC region. The aftermarket business was up 2% year over year and its share increased from 45% to 47% in quarter two. This development is remarkable because many rail operators still having a lower number of trains in service due to COVID restrictions, lower ridership levels and the tighter supply chain that took its toll. China continues to face a strong rail market weakness and a slower recovery than expected from its lockdowns, both visible in OE and aftermarket business. Overall, Chinese revenue decreased year over year by 10%, which is much better compared to the 30% drop in the first quarter 2022. In North America, we recorded an increase in the OE and aftermarket business. We expect the sequential quarterly improvement from now on and anticipate that in 2022 overall, RBS revenues should grow solidly, predominantly driven by the OE business in Europe and North America. Aftermarket demand should increase too, strongly depending on the development of rail traffic and travel restrictions, especially in China. Operating EBIT margin of RVS in Q2 reached 14.3% after 18.4% a year ago. The main influencing factors on this week's development was the regional mix with much lower profit contribution from China. In addition, revenues and profits in Russia were significantly lower in the last quarter. Also, the input of higher inflationary cost was visible as the countermeasures will come in during the year with a certain time delay. In the remaining six months, we expect to benefit from price increases to our customers and a slightly better development in China. Let us continue with truck on slide eight. Incoming orders of CVS amounted to 881 million euros, which is a decline of 18% year over year. A strong decrease after several quarters of record levels and the result of the ongoing weak Chinese market, as well as component shortages on the customer side with the consequence of a managed order book. We see strong underlying demand in Europe and North America, but OEMs are restrictive in taking orders from truck fleets because they have production bottlenecks. APEC, especially driven by China, remains on a low level. The order book of our truck division reached 1.9 billion euros at the end of June, which is a remarkable increase by 16%. Book-to-bill in quarter two was at 0.96%. Currently, market demand is not our biggest concern, and we rate the quality of our high order backlog as very good. Our problems, which we share with the whole truck industry, are the availability of parts and the stability of supply chains. Let's move on to slide nine. CVS posted €914 million in revenues in Q2, which is an increase of 4% year-over-year and a very good result considering supply chain disruptions and issues in China. In Europe and North America, CVS saw a positive development in all channels, OE as well as aftermarket. The APEC region still ranges on low levels after the China 6 introduction last year and the additional industry slowdown driven by zero COVID measures in the second quarter. The utilization of fleets continues to be high, which drives demand for spare parts and services. Consequently, the share of aftermarket revenues increased from 25% to 27% in the last quarter. In absolute terms, that means aftermarket business increased by a strong 30 million euros, reaching 250 million euros. In the coming quarters, CVS should be able to post a solid increase in revenues quarter over quarter. This positive outlook depends on the global supply chain situation and somehow a catch-up of truck production rates in China in the latter part of half year two. In quarter two of this year, CVS achieved an EBIT of 74 million euros, which is 24% lower year over year. The EBIT margin amounted to 8.1% compared to 11.2 a year ago. This margin development was highly affected by the lower contribution from China as well as Russia. In addition, cost pressure from inflation and supply chain headwinds took its toll. CVS concluded price negotiations with many customers already. Major benefits from these negotiations will be reflected in improved margins in the second half of the year. Let's move on to chart 10. The impacts of the Russian war in Ukraine and Knorr Bremses' previously announced withdrawal from business in Russia resulted in a meaningful adjustment of the guidance, as communicated on July 27th. Our direct exposure in Russia on a full year basis amounts up to 200 million euros in revenues, of which we expect to lose roughly 130 million euros this year. On the margin side and on group level, we expect to lose roughly 70 basis points on Knorr Bremse group level. The withdrawal from Russian activities resulted in non-operating and non-cash expenses of 18 million euros, which is reflecting a write-off of inventory. Additionally, we have a deconsolidation effect of 9 million euros for the KB Kamath joint venture in our financial result. There could be an additional non-cash relevant maximum risk of additional up to 32 million euros for accounts receivable based on our calculations currently. So far, we have not faced any payment defaults though. Currently, we only fulfill existing contracts as long as they are not impacted by sanctions and we are not generating new businesses in Russia. Let's move to page 11. Chinese rail and truck markets currently face strong headwinds. The recovery after their strict lockdowns is sluggish and puts companies active in China and around the world in challenging situations. Knorr Bremse is not an exception. On the rail side, 2021 had already seen a certain market downswing in metro, fueled by a tougher environment in real estate, which is an important basis for the funding infrastructure investments, and high speed due to ongoing low ridership. Looking into 2022, rolling stock figures should range even below 2021 levels. RVS is designed in the current platforms in metro and high speed. but with a lower number of produced rail cars, we sell less KB products. So please let me be clear. It's not about market share losses which led to lower revenues. We are fully in line this year regarding market share development in Metro, and we are stable in high speed. Regarding market recovery, we only expect very little progress in the second half of this year. Truck production rates are also affected by a strong decrease of the Chinese market after the China 6 introduction in July 2021. The additional hit from the zero COVID policy takes its toll, resulting in half year two, half year one TPR of about one third compared to the first half of last year. Until year, we expect only some recovery of truck production rates in China, and consider 720,000, 25,000 in our full year guidance. One important strength of our business is the outperformance of underlying markets. This was again the case in China in the first half of 2022. Let's move to page 12. To fight inflationary headwinds, we have defined a clear action path that is already being implemented. first via price negotiations and second via our group-wide profit and cash protection program. Our goal is to offset all inflationary headwinds, which is unchanged, despite the fact that we now expect those to be around 300 million euros for the full year 2022. We plan to compensate around two-thirds of these headwinds via price increases to our customers and around a third via all other measures. really focusing here on own cost and efficiency measures. A quick update on the ongoing price negotiations. We have already achieved good results with our aftermarket customers in both divisions. This is also the case with several of our major OE customers in truck. The rail industry is of a more difficult nature. We finished important negotiations successfully already, First effects will be visible in the second half of 2022, while some benefits will spill over even into 2023 due to longer cycles of contracts and binding durations of price sliding clauses. Let's move to page 13. I have included this slide to give you transparency on all the headwinds we are currently facing and their impact on our outlook for this year. China is a clear burden. The before-mentioned market weakness with much lower volumes in both the rail and the truck market should lead to a burden of roughly 120 basis points in EBIT margin this year. In addition, the impact from the lost Russian business reduces our operating EBIT margin by 70 basis points. The good news is that with all our strong efforts of our profit and cash protection program, we are confident to compensate all the remaining headwinds in a nutshell. Also, the quite high level in regards to the degree of implementation for the measures underlines that confidence. That clearly shows the strength of Knorr Bremse. We therefore, as a result of all that being said, moderately expect moderately higher profitability in the second half of 2022, resulting in a group operating guidance of 10.5 to 12% for full year 2022. On chart 14, we confirmed the revised operating guidance for 2022, given on July 27th. We increased the lower end of our revenue guidance and now expect revenues between 6.9 to 7.2 billion euros, an operating EBIT margin between 10.5 and 12%, and free cash flow between 300 and 500 million euros for 2022. Please note that this guidance is based under the assumptions outlined on the right side of page 14. Let's finish with an update on RBS China and recent M&A activities. On page 15, we explained at our CMD last year that we have a clear two-pillar strategy going forward. First, we want to leverage our existing strong market positions in both divisions to grow and secure our existing core business fields. Second, we want to leverage our strong foundation and expand into new growth markets of digital businesses following the strong underlying megatrends both organically, but also via acquisitions and partnerships. Let me outline RBS development in China and what we expect in the years ahead on chart 16 for our core business. Revenues declined since peak levels in 2014-15, despite significant market investments, driven by market share losses in high speed as expected. In the last two years, also COVID took its toll, and despite rather stable market shares, lower market investments could not be overcompensated. We believe infrastructure investments will continue in the coming years, which definitely will lead to new rail vehicles. On top, rail traffic should improve from the low levels eventually, even though it is currently difficult to assess when this will exactly be. Therefore, we expect aftermarket revenues to increase again in the future, and CRRC's ambition to expand abroad is an opportunity. Overall, we expect slight market share losses in metro in the next couple of years, while high-speed market share should remain rather stable. Nevertheless, we expect RVS sales to continue to decline slightly, but we see a level of around €600 million as a sustainable floor. With that floor that we currently see, we expect the aftermarket share to increase steadily. Also, profitability will reduce over time. So what do we do in China? We are expanding our aftermarket footprint there. We started an efficiency program under PCPP to move the organization from growth to a sustainably lower fixed cost base. We are doing everything we can to remain the innovation and quality leader in China. China is still a great business for Knorr Bremse, just not the big growth driver anymore. But China will stay a meaningful contributor to KB's profits and cash flow. Regarding growth, we see more opportunities in other regions, especially Europe and North America, and we will exploit those. In addition, we are working on other profitable segments in rail, which should be able to partially compensate the expected development in China. Of particular interest, here are freight segment, digital coupling, and digitalization in the aftermarket business. Please move to slide 17. In July, we announced the acquisition of Kojali, which will strengthen CVS aftermarket and digital business with highly accretive margins. Kojali is a world leader developing and manufacturing of jail test diagnostics, the multi-brand diagnostic system for commercial and other vehicle types in the aftermarket segment. We are strengthening our existing aftermarket business by investing in a commercial vehicle specific diagnostic solution that will open up new business opportunities for us in the fields of big data and predictive maintenance based on big data. CVS aftermarket revenue share will expand by approximately 150 basis points. Let's have a look on our Nexiot investment on page 18. We have concluded a comprehensive cooperation agreement and became largest shareholder of Nexiot contractually, enabling RVS to make full use of Nexiot sensor technology and data ecosystem. Once RVS brakes, doors, HVAC, sanitary and other systems are connected with Nexio's digital ecosystem, we will be able to generate data. This information will enable us to set up new business models, increasing vehicle availability, optimize lifecycle costs and greater operational efficiency. I would like to thank all colleagues, employees, business partners, and customers for their tremendous efforts in this challenging quarter and times. And with that, I'll turn the call back to the operator to begin the Q&A session with my colleague, Jürgen. Thank you.